A man wearing a protective mask walks past 14 Wall Street in New York’s financial district on November 19, 2020.
Shannon Stapleton | Reuters
A volatile environment for government bonds reflects a very uncertain future for the US economy, indicating both slower growth and persistent inflation.
After a surge earlier this year that spooked markets, Treasury yields fell sharply as investors moved away from worries about price increases and turned to the potential that the rapid surge in post activity. -pandemic begins to slow down.
In the 1970s, the mix of higher prices and lower growth was called “stagflation,” a derogatory term that has garnered little attention since then, as inflation has remained under control over the past decades.
However, the word is coming up more and more these days as the growth chart gets cloudier.
“The market is trading on the topic of stagflation,” said Aneta Markowska, chief financial economist at Jefferies. “There is the idea that these price increases will destroy demand, cause policy error and ultimately slow growth.”
For her part, Markowska believes the trade that caused 10-year Treasury yields to drop from a high of around 1.75% in late March to around 1.18% earlier this week was a mistake. Yields are trading at opposite prices, so a drop there means investors are buying bonds and pushing prices up.
She sees a strong consumer and an upcoming eruption of supply, reversing the current bottleneck that pushed prices to their highest levels since before the 2008 financial crisis, as generating a lot of momentum to maintain growth. on the move without generating runaway inflation. Markowska predicts that the Federal Reserve will remain on the sidelines until at least 2023, despite recent market prices that the central bank will start raising rates at the end of 2022.
“The consensus is for 3% growth. I think we could grow 4% to 5% next year,” Markowska said. “Not only is the consumer still very healthy, but you’re going to have a massive replenishment of inventory at some point. Even if demand goes down, supply has so much catching up to do. You’re going to see the mother of all. restocking cycles. “
The bond market, which is generally viewed as the more subdued component of financial markets as opposed to the go-go stock market, doesn’t seem so convinced.
The low growth world is coming back
The 10-year Treasury is considered the barometer of fixed income and generally a barometer of the direction of the economy as well as of interest rates. Even with Wednesday’s rally in yields to a 1.29% Treasury does not express much confidence in the future growth path.
“We believe growth and inflation are moderate,” said Michael Collins, senior portfolio manager at PGIM Fixed Income. “I don’t care about growth and inflation this year, what matters to our 10-year Treasury forecast is what it’s going to be over 10 years. And I think it’s going to come back down. the world we live in. “
As the economy grew after the government-imposed pandemic shutdown, GDP has been well above the around 2% trend that had prevailed since the end of the Great Recession in 2009. The recession of Covid was the shortest on record, and the economy has been rocketing since mid-2020.
Consumer prices have gone up a high 5.4% in June while the prices that producers receive rose 7.3%. Both figures point to continued price pressures that even Federal Reserve Chairman Jerome Powell admitted to being more aggressive and persistent than he and his central bank colleagues had anticipated.
While the decline in yields indicates that some of the worries have exited the market, any other sign that inflation will persist longer than expected by policymakers could quickly change investors’ minds.
This is because of the swirling dynamics that threaten to raise this specter of stagflation. The biggest growth concern right now is the threat posed by Covid-19 and its delta variant. Slower growth and rising inflation could be lethal to the current investment landscape.
“If the virus begins to spread rapidly again, it would dampen economic growth and prolong the inflationary supply chain disruptions that have plagued so many industries, including semiconductors and housing,” said Nancy Davis, founder of Quadratic Capital Management and portfolio manager of Quadratic Interest. Exchange traded fund against rate volatility and inflation.
The Treasury market is often much more deliberate than its equity-focused counterpart, which can swing a lot in the headlines both good and bad. At its current level, the bond market is cautious about the future.
“Considering what has happened over the past 18 months and the challenges that much of the world is facing over the next 2-3 years, a rate of 1.2% over 10 years is understandable,” wrote Nick Colas, co-founder of DataTrek Research. “This doesn’t mean stocks are doomed to have a tough 2021 rest, or that a crash is imminent. It means Treasuries have a healthy respect for history, especially the value of inflation. US below the decade average. “
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